Palantir (NYSE: PLTR) is a great example of a stock whose business is excelling, but whose shares may be too expensive to warrant buying. After all, even the best companies bought at the wrong price can be a disastrous investment.
But what does history say about highfliers like Palantir?
Palantir's AI product has accelerated growth
Palantir's product is centered around providing its clients with software powered by artificial intelligence (AI) that aids in making decisions. This was originally developed for government use, but Palantir eventually expanded into the commercial arena to capture a larger market opportunity.
Palantir has had AI software available for some time, but the launch of its Artificial Intelligence Platform (AIP) product has been a true game changer. AIP allows companies to integrate large language models (LLMs) into their internal servers. This allows generative AI models to run on in-house data, giving its users the best information at any point in time. Because AIP gives clients the tools to integrate AI into a business, it's a key software that takes AI from a product that's used on the side to one that's fully meshed.
According to management, demand for AIP has been "unprecedented," and that growth is showing up in Palantir's U.S. commercial segment in particular. In the second quarter, U.S. commercial revenue was up 55% year over year, supercharged by its customer count rising 83% year over year. While U.S. commercial revenue accounts for about a quarter of overall revenue, the rest of Palantir's business is also doing well. Overall, Palantir's revenue grew 27% year over year to $678 million.
Management also expects its growth rate to continue to be strong. Third-quarter revenue is expected to come in at $699 million, indicating 25% revenue growth.
While those are solid results and guidance, is it enough to justify Palantir's price tag?
Palantir's stock has outrun its business results
Palantir is profitable but has yet to achieve an optimized profit margin, so I'll use its price-to-sales valuation to assess the stock. At 35 times sales, Palantir stock is incredibly expensive.
PLTR PS Ratio data by YCharts
The last time Palantir reached this level was in 2021, but that was when its revenue was growing around 40% year over year. Palantir's growth rate is projected to moderate next quarter, and Wall Street analysts only expect 21% growth next year. As a rule of thumb, when a company's price-to-sales (P/S) ratio exceeds its revenue growth rate, the stock is incredibly expensive and should likely be avoided.
Palantir is even more expensive than this rule of thumb, and history suggests that a correction could be imminent. This has been seen in other software stocks that were excelling at a certain time as well. Zoom Video was booming with its video conferencing technology during the pandemic, but its valuation collapsed as the demand was fulfilled.
ZM PS Ratio data by YCharts
I don't know if Palantir will be the next Zoom Video, but one thing is for sure: Palantir's stock is incredibly pricey. If you're sitting on healthy gains, it may be wise to trim some of that profit and let it sit in cash or redeploy it to other opportunities available in the market.
The stock's valuation far outweighs its actual business results, and I wouldn't be surprised to see a sell-off in the future.
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Keithen Drury has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Palantir Technologies and Zoom Video Communications. The Motley Fool has a disclosure policy.
